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Philantrophy After the Fall

October 10, 2010

The notion of socially responsible business has always worn many guises. It has been equated variously in both the public and the corporate minds with philanthropy or environmentalism or sustainability or ethics. And, almost without exception, it has seemed a bit artificial — a cosmetic overlay having little to do with business fundamentals. A number of leading thinkers, however, believe that one of the legacies of the “great” recession may be that it is enforcing the kind of real alignment between social aims and business profitability that has eluded social investors for decades.

“If you go back 20 years, companies like Nike, Nestle, Coca-Cola and Wal-Mart regarded it as a badge of honor to be seen as not soft and sentimental and socially progressive,” said Matthew Bishop, The Economist’s New York bureau chief in a recent interview with INSEAD Knowledge. Bishop, who is a co-author with Michael Green of “The Road from Ruin: How to Renew Capitalism and Put America Back on Top” (Crown, 2010), believes the global economic crisis has prompted an urgent re-examination of how capitalism can be made to work more in concert with societal aims: “In boardrooms now, there is an understanding that, as they think long term, they have to be on the right side of social progress.”

In the short term, the recession has certainly had a profound negative impact on philanthropy and social investment. According to Maximilian Martin of the University of Geneva Faculty of Economic and Social Sciences, the 18-month recession left foundation endowments down 30 to 40 percent in the United States and 20 to 30 percent in Europe. In 2009, about two thirds of foundations in the United States reduced their payouts. In the United States alone, 460 foundations lost 80 percent or more of their endowment assets. Not surprisingly, many foundations instituted hiring and salary freezes and severely cut budgets.

Although Martin admits that these downward adjustments will hold back net worth and endowment assets for years to come, his recent paper, “Managing Philanthropy after the Downturn: What Is Ahead for Social Investment?” (Viewpoint, Social Science Research Network, 2010), makes the case that the recession has already begun to create fertile takeoff conditions for future philanthropic investment by forcing philanthropists to be smarter — to increasingly seek to leverage their capital, lower costs, spread risk and simplify and consolidate their efforts. He discusses several strategies that are gaining favor, including time-bound subsidies, joint capital pools and “synthetic” social businesses.

A time-bound subsidy is essentially a catalyst for an initiative that will later seek commercial financing to fund further expansion. “Proof of concept often needs grant money; and scaling up requires commercial money,” explains Martin. “Time-bound subsidies are an instrument for philanthropists to ensure that once initiatives no longer need subsidies, the philanthropic money is redirected to some other area where it can make a difference.” Martin points to Banco Compartamos, a Mexican microfinance bank with 1.4 million clients and a total active loan portfolio of $550 million, which began life as a grant-funded nonprofit.

In situations where grants alone cannot do the job and investment capital is often unwilling to go into the riskier or less conventional markets where the need is greatest, a joint capital pool offers a solution. It seeks to combine philanthropists, social investors and commercial investors into consortia or funds that take into consideration the different risk tolerance, return objectives and expertise sets of each group. “For example,” says Martin, “a charitable foundation may be inclined to provide grant funding while a social investor may be willing to provide subordinated debt at a relatively low interest rate and a purely commercially minded investor would make equity investments based on the consideration that part of the risk has already been absorbed by the other types of capital providers.”

Finally, Martin believes that more and more businesses will begin to operate as “synthetic” social businesses. “That is,” he says, “a business venture whose social purpose is encoded in the holding structure of the company. This means that a philanthropic foundation holds a significant ownership stake and special voting rights with the mission to make the good or service available to as many people as possible around the world.” A synthetic social business is developed just like any other business, operating according to private-sector principles and making use of private-sector management talent. But since the company inherently seeks to serve the broadest possible swath of society, it is more likely to produce in higher volumes at lower margins and use tiered pricing strategies and the like.

One such organization is The Petra Group of Malaysia, which provides financial and management support for early-stage technology businesses. Petra is 60 percent owned by the Sekhar Foundation, the company’s charitable arm, which supports a multitude of environmental, educational and children’s causes around the world. “You can’t do anything that’s going to make a global impact unless it’s commercial,” says Petra’s president and chief executive officer Vinod Sekhar. “We should be smart enough to be able to do that and do some good along the way.”

Michael Bishop echoes that sentiment: “Relying on charity is never a good place to be, whereas if you have a profitable business, then you’re always going to find investors.”

There are at least two potential problems, however, with this vision of “new” philanthropy.

Martin articulates the first problem in his paper, saying that as investor demand grows for social investment opportunities, their commercial aspects would dominate and “their social impact standards risk being watered to the extent that social investment would become largely a marketing exercise.” That is to say, we’d essentially be back to square one.

The second problem has been voiced by, among others, former Ford Foundation director Michael Edwards, author of “Small Change: Why Business Won’t Save the World “(McGraw-Hill, 2010). Edwards asserts that business by its very nature is not equipped to address long-term social transformation, which, he says, is neither easy to measure nor always cost-effective in profit-maximizing terms. It requires a different set of operating values that emphasize cooperation over competition, collective action over individual effort and systemic solutions over immediate results.

The real solutions, says Edwards, lie in “businesses acting more like civil society, not the other way around.” At the end of the day, that may turn out to be an important insight not only for determining the post-recession future of social investment, but for figuring out how to eliminate the problems that got us into the recession in the first place.